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Is the Solera Holdings Transaction a Setup?

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The annualized return is probably right

In the Solera Holdings (SLH) merger, you’re getting an almost 9% annualized yield. That’s probably a reasonable return in such a low interest rate environment.

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Be careful with private equity buyers

Private equity transactions often have attractive spreads, but that’s because there’s added risk. Private equity transactions rely on easy access to cheap financing to make them work.

The private equity buyer, then, injects equity into the company, but they still have to find the funds to buy out the existing shareholders. That payout is almost always financed. If there’s stress in the financial sector, these spreads typically widen out, causing pain for arbitrageurs.

Beware of “subject to financing” transactions. While the Solera deal has committed financing, some private equity deals don’t. If the deal is subject to financing, it means the money might not be there to buy out the shareholders once the deal is set to close. In any sort of financial market hiccup, these are the first deals to be thrown overboard.

Watch also for “reverse termination” fees. Private equity buyers will often put these in merger agreements, where the buyer can pay a fee and walk away from the transaction. In this case, you haven’t sold your stock—you have sold a call on your stock. If the markets hiccup, buyers will pay the reverse termination fee and walk away.

Private equity deals always carry more risk than commercial transactions. Consider that financial buyers have to have an extra layer of risk that strategic buyers don’t have. It’s thus unwise to build a portfolio out of mainly private equity deals.

Merger arbitrage resources

Other important merger spreads include the deal between Baker Hughes (BHI) and Halliburton (HAL) and the merger between Freescale Semiconductor (FSL) and NXP Semiconductor (NXPI). For a primer on risk arbitrage investing, read the series Merger Arbitrage Must-Knows: A Key Guide for Investors.

Investors interested in trading in the technology sector should look at the S&P SPDR Tech ETF (XLK).

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